The spark set to ignite Canada’s next big corporate credit shakeout looms as companies pile on too much debt

'Cheap loans, high leverage and an abundance of capital really for the last decade is the gasoline'

"We don't know what the spark will be, but we do know — because history has a way of repeating itself — that at some point there will be a spark," said Neil Selfe, founding partner of Infor Financial Group.Postmedia News files

Infor Financial Group Inc., an independent investment bank, is preparing for a major shakeout in corporate credit as Canadian companies pile on too much debt.

After more than 10 years without a major corporate failure, banks are “aggressively” expanding into corporate loans, adding to a debt pile built on the back of ultra-low interest rates, said Infor founding partner Neil Selfe. Canada hasn’t seen the failure of a major corporation since Nortel Networks Corp. in January 2009.

“We don’t know what the spark will be, but we do know — because history has a way of repeating itself — that at some point there will be a spark,” said Selfe, who was co-head of global technology, media and telecom banking at Royal Bank of Canada until 2004, during an interview at his office in Toronto. “Cheap loans, high leverage and an abundance of capital really for the last decade is the gasoline.”

Weakness Appears

Potential cracks have started to show. Toronto-Dominion Bank and Canadian Imperial Bank of Commerce, the country’s second and fifth largest banks, bolstered provisions in the last fiscal quarter, citing a rise in corporate arrears among the reasons.

Canadian companies’ interest expenses almost doubled this decade to $10.8 billion (US$8.1 billion) at the end of the year from $5.7 billion in the first quarter of 2010, according to government data. While interest revenues that companies get from their interest bearing investments were at $18.7 billion in the last quarter of 2018, the rate of interest expenses jumped three times faster than revenue from interest bearing investments.

Credit to Canadian businesses rose in the last 12 months through January by 6.1 per cent to $2.18 trillion, while lending to households expanded 3.1 per cent and reached $2.16 trillion, according to Bank of Canada data. Lenders are expanding credit to companies even as the country’s economic growth almost stalled in the last quarter of 2018 as consumption spending grew at the slowest pace in almost four years, housing investment fell by the most in a decade, business spending dropped sharply for a second straight quarter, and domestic demand posted its largest decline since 2015.

Business Ramp Up

Infor is getting ready — it’s hired veteran restructuring expert Paul Liebovitz, who is already advising publicly listed companies in the renegotiation of their debt facilities, Selfe said, declining to provide the name of the firm. Infor is also turning to pension funds and insurance companies to fund debtor-in-possession loans, a type of credit for distressed companies, said Selfe.

“There were very few, if any DIP providers in Canada” said Selfe. “This is one of the areas that we think is a ripe opportunity.”

While companies in the mining and oil & gas sectors have been in a downturn for several years, the restructurings could be expanded into some of the suppliers of those industries as well as services firms, said Selfe. Also, some ‘veteran’ services industries, or manufactured or sport or niche manufacturing industries, may also being forced to reorganize their balance sheet.

Infor Financial Group founding partner Neil Selfe.National Post files

“There’s often very, very little left if they hit the wall. It’s not like a mining company or an oil and gas company where at the end of the day you’re left with a mine or an oil and gas facility,” said Selfe. “The banks will do whatever they can to prop up those companies because in a blowup their recovery is very little.”

While Infor restructurings activity takes off, investment banks in Canada may continue to see a steady flow of mergers among the mid-size and small players in the Canadian cannabis industry, he said. For that to happen there should be a closing of the current gap between the values that “small players think they’re worth and what the larger players are now willing to pick them up,” he said.

“We do think there’s a few mid tier players that will still pick-up Canadian assets and we’ll try to push into that top ten,” said Selfe. So it’s really the mid tier producers buying small tier producers. Above the one billion dollar threshold “we think that most of that activity is going to be focused globally and outside of Canada.”

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